Iran’s Currency Crisis Spurs Action in Financial Reform Efforts

In the 2017 anti-money laundering (AML) index report published by the Basel Institute on Governance, which develops standards for financial regulations and compliance, Iran topped the list of the world’s 10 highest-risk countries failing to comply with AML standards. This index, published since 2007, ranks 140 countries in terms of their efforts combatting dirty money transactions and countering terrorist financing (CTF). Iran has made little progress to date in improving its standing. Yet, the recent reunification of Iran’s exchange rates by central bank is seen to be an effective step toward more economic transparency and part of wider efforts against smuggling and rent seeking in their diverse forms.

The high-risk assessment of Iran highlighted in the Basel Institute report is primarily due to weak AML/CFT regimes practiced in the jurisdiction. High rates of perceived corruption combined with poor financial sector regulations are major drivers of the structural and functional failures in the Iranian economy. Importantly, these are among the critical issues, which the Financial Action Task Force (FATF), an intergovernmental organization which develops politics to combat financial crime, had mandated Iran to address as part of its "action plan."

Following an extension granted in February, the deadline for Iran’s compliance with FATF’s action plans is set for June 2018. This means that Iranian authorities have limited time at their disposal to earn the continued suspension of counter measures against Iran. Lack of membership in organizations such as the World Trade Organization and the FATF, in particular, has led to a myriad of problems in the implementation of the Joint Comprehensive Plan of Action (JCPOA) nuclear deal agreed by Iran and E3+3 in 2015. Due to shortcomings in meeting FATF technical requirements and Basel II and III banking regulations, Iran has failed to expand its business and correspondent banking ties with International financial institutions, with significant consequences. For example, the number of letters of credit  opened since “Implementation Day” has been far lower than expected.

As such, financial reform in Iran is motivated by the need to spur economic growth. The mandate that the Supreme Leader of Iran Ali Khamenei gave to the Rouhani government to start negotiations with world powers over Iran’s nuclear program reflects the wider policy of the state to continue interacting with the international bodies on economic matters. To that end, cooperation with the FATF is set to carry on unless that authorization is withdrawn. Yet given the importance of such reforms, this authorization may remain in place regardless of what happens on May 12 with respect to President Trump’s decision to extend sanctions waivers issued as part of the JCPOA.

According to some estimates, the magnitude of organized money laundering in Iran amounts to some USD 26 billion per year. Transacting such sizeable amount of money outside the official financial system is impractical and requires that criminals abuse the conventional financial system to support their illegal activities. The Central Bank of Iran is seeking to increase its powers of supervision to monitor and prevent suspicious money transfers and smuggling of goods, ensuring the integrity of Iran’s financial system.

The central bank's recent moves to stem currency market volatility will make financing of illegal businesses in the economy more difficult. CBI’s new policies prohibit purchasing or holding of more than USD 10,000 or its equivalent in international currencies. In the same parallel, any bank account that whose aggregate debits and credits exceed IRR 50 billion rials  will be subject to anti-money laundering probes to monitor for suspicious activities.

Although it will remain possible to find loopholes in the new regulations, these moves reflect significant progress after years of unfulfilled promises to unify the dual foreign exchange rate regime. The move is also viewed as an important step towards obtaining approval from FATF in respect to countering money laundering and removing the rentierism prevalent in the country’s largely state-controlled economy.

In addition, based on the new legislation, revenues from petrochemical exports that are not repatriated to the country will be subject to greater supervision. Firms in the industry will now be required to report their trade transactions in the same system used to record the oil companies’ export revenues.  Previously earnings from petrochemical products sales were kept outside Iran in offshore bank accounts in the absence of proper supervision over their transactions and trades.

Interestingly, to further reinforce its oversight, the central bank has launched the an integrated system for monitoring foreign exchange deals or known as NIMA. This is a system which will monitor the activities of four groups of actors who shape the currency market: merchandise and service importers who purchase foreign currency, exporters of goods and services who earn foreign currency, banks and brokerages who act as intermediaries, and the policymakers who seek to manage supply and demand.

According to CBI governor, Valiollah Seif, the operationalization of the NIMA, will change CBI’s current reactionary response mechanism to one that is more proactive and will make controlling hazardous speculative or systematic fluctuations in foreign exchange markets possible by enabling the calculation of the effective demand so that the bank can aptly manage the available foreign exchange reserves.

In sum, the implementation of these targeted measures by CBI is expected to gradually put an end to capital flight and massive conversion of rial to other hard currencies. These moves can also undercut crimes such as smuggling and money laundering by increasing oversight and the likelihood of penalties for their perpetrators. But the effectiveness of CBI’s mandate will be determined by the political will of both the government and the state to fully enforce the letter and spirit of the new regulations and laws. A great deal is at stake. If the Rouhani government can continue to persist in its long-awaited macroeconomic policies and resist pressure from vested interests, then it remains possible that Iran’s economy could find new momentum after years of recession.

Photo Credit: Tasnim

Rouhani Government Unifies Iran’s Exchange Rates in Decisive Move to Stabilize Currency

In a decisive move intended to stop the further devaluation of the rial, the Rouhani government announced it would unify the official and free market dollar exchange rates, settling on an official rate of IRR 42,000.

First Vice President Eshagh Jahangiri made the announcement last night, declaring that trading dollars above the new rate would be a serious crime.  "Just like the smuggling of drugs, no one has the right to buy or sell [above the new rate]... If any other exchange rate is formed in the market, the judiciary and security forces will deal with it," he warned.

"There should not be such incidents in an economy that always has a surplus of foreign currency. Some say interference by foreign hands is disrupting the economic climate and some say domestic machinations are spurring these things in order to destabilize the climate in the country," added Jahangiri.

Earlier in the day, the Economic Commission of Iran’s parliament had summoned Minister of Economic Affairs Masoud Karbasian and Central Bank Governor Valiollah Seif for an emergency meeting regarding the careening value of the rial, which had reached a record low of IRR 60,000 to the dollar.

Speaking to reporters after the meeting, Karbasian continued the government line that the devaluation was not a reflection of the true state of the economy. Rather, he obliquely suggested that the “security agencies” ought to be summoned to explain the real cause for the fluctuations. His comments were an apparent reference to rumors that certain actors opposed to the Rouhani government, likely in the security establishment, were hoarding dollars in order to exacerbate speculation and undermine confidence in the government’s economic management.

However, in the face of this significant political pressure, the Rouhani administration made a bold move, instituting a policy that has eluded the country’s economic planners since the 1979 revolution. Rate unification has long been considered a necessary step to introduce more stability in Iran’s monetary policy and foster a better business environment for the country’s enterprises.

Iran's last major currency crisis of a similar scale took place in 2012. Then president Mahmoud Ahmadinejad similarly blamed psychological factors for the rout, arguing in a speech, "Are these currency fluctuations because of economic problems? The answer is no. Is this because of government policies? Never … It's due to psychological pressure. It's a psychological battle." His government similarly tried to unify rates at IRR 12,260. But sanctions made it difficult to generate sufficient supply of hard currency in Iran, and the unified rate collapsed after just a few months. 

During this most recent currency crisis, the rial had lost about one-third of its value against the dollar over the last Iranian new year, which ended on March 20. The devaluation accelerated beginning in December, and the rise in the free market price of the dollar tracked closely with that of gold. Both gold and the dollar have been typical “safe-haven” investments for Iranians wishing to hedge against inflation and general economic uncertainty. However, inflation had remained flat over the previous twelve months, and real estate prices were relatively stable, suggesting little change in the purchasing power of the rial. The net effect was a rampant devaluation more akin to a bubble, fueled by rising doubts among Iranians about the survival of nuclear deal.

Though clearly responding to the recent turmoil, the Rouhani government had already begun the groundwork necessary for such a unification. In March of last year, Catriona Purfield, a senior economist at the IMF, suggested that Iran could perhaps unify the rates earlier than expected, stating, “Half of imports have been put on the market rate and most of the goods are now at the flexible rate. Interbank FX market has been reestablished. Therefore all the elements are there, so an early move is possible.”

The new rate of IRR 42,000 is closer to the rate economists expect would be necessarily for unification. Economists Mohsen Bahmani-Oskooee and Sahar Bahrami looked at exchange rate data from 1979 to 2015. They concluded that had Iran’s rial been allowed to depreciate in accordance to changes in purchasing power parity, the exchange rate in 2015 would have been around IRR 47,000. The rial’s purchasing power has been relatively stable in the last few years and so this is likely a fair estimation of the current dollar rate in PPP terms.

Yet, despite the clear economic rationale behind the rate unification, it will remain to be seen whether the political gamble pays off for Rouhani. The official exchange rate presented a lucrative arbitrage opportunity for quasi-state actors, who could purchase dollars at the lower official rate then sell the hard currency on the black market. These entrenched interests will no-doubt see the unification as a direct challenge by Rouhani, and a further example of his administration's continued efforts to reign-in rent seeking in the economy.

But for the general public, such a confidence-inspiring move should serve as an indication that the Rouhani cabinet, despite the claims of infighting and mismanagement, remains capable of the kind of coordinated policymaking necessary to reform the economy.

Photo Credit: Vahid Salemi

Governor of Sweden’s Central Bank Visits Iran for Technical Dialogue

The governor of the Riksbank, Sweden’s central bank, will visit Iran on April 5-6 at the invitation of Iran’s central bank governor Valiollah Seif.

Stefan Ingves, the governor of the Riksbank will be leading a day of technical exchanges including a working dinner hosted by Sweden’s ambassador in Tehran, Helena Sångeland. The visit, which comes as political uncertainty around the nuclear deal reaches a fever pitch, underscores the long-standing commercial and economic relationship between Sweden and Iran. In February of 2017, Swedish Prime Minister Stefan Löfven visited Iran with an itinerary that included a visit to the Scania truck factory in Qazvin. 

For the Central Bank of Iran, the visit by one of Europe’s most seasoned central bankers is a valuable opportunity to draw on the Riksbank’s experience in central banking, financial stability, and monetary policy. Ingves has held the position of Riksbank governor since 2006 and navigated the country through the 2009 global financial crisis. He is also the chairman of the Basel Committee on Banking Supervision, which sets global standards for prudential regulation of banks. Iranian banks have been undertaking extensive reforms in order to better conform to so-called “Basel” standards.

A spokesperson for the Riksbank confirmed to Bourse & Bazaar that Ingves will give a presentation entitled “Central Banking and Financial Crisis: Lessons Learned.” The topic is of particular relevance as Iran seeks to manage systemic risk in its banking sector stemming from non-performing loans, a key driver of the 2009 crisis. Sweden was one of the fastest recovering countries in the aftermath of the last major global recession, earning praise as a “rockstar of the recovery” for its combination of intelligent fiscal and monetary measures. 

No doubt, Iran’s central bankers will listen to Ignves’ presentation attentively.

Photo Credit: Riksbank